B&Q an Economic Analysis

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  • Topic: Cost curve, Homebase, Average cost
  • Pages : 9 (3345 words )
  • Download(s) : 167
  • Published : July 19, 2008
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1B&Q Background
B&Q PLC is the UK retail arm of Kingfisher Group PLC and is the UK’s leading DIY and garden centre retailer. It was founded as a privately held company in Southampton, England in 1969 and went public in 1979 before acquiring Scottish DIY chain Dodge City in 1980. B&Q was itself acquired in 1980 by F. W. Woolworth only to be sold two years later to current owners Kingfisher Group. B&Q PLC contributes 45% of Kingfisher’s total retail sales. B&Q dominates its sector, in competition with three other large UK DIY superstores; Homebase; Wickes; and Focus; as well as a large number of much smaller retailers and builders merchants.

Figure 1: Market Share and Profit per %point of share (Source: Mintel, Fame) Figure 1 shows B&Q’s market dominance with a 49% share of retail sales and also highlights the profitability of its operations, delivering around 30% more profit from each percentage point of market share than its two closet rivals. 2Vulnerability and Costs

Vulnerability may be determined by the steepness of the Short Run Average Total Cost (SRATC) curve. B&Q’s SRATC curve is driven by; Distribution Costs, Property Costs, Energy Costs, Staffing Costs (Quasi-fixed) and Debt Interest. B&Q owns a property portfolio valued at £800M, most of which is used for trading purposes. There has been no significant addition to the property portfolio over the past 5 years suggesting B&Q are operating at the optimum number of properties. The portfolio is financed by debt. In 2006 B&Q reduced its debt and released equity by selling and leasing back a number of properties. Rising oil prices have increased energy supply and distribution costs. Distribution and warehousing is subcontracted to Exel Logistics on a 5 year contract and can be considered a short run fixed cost B&Q employs close to 37,000 staff on varying contracts with an equivalent of 26,273 full time staff. As the company is focused on customer service it invests heavily in staff training and development therefore I suggest the staff costs should be considered as quasi-fixed in the short run. B&Q’s gearing ratio seems relatively low in the sector (see figure 2), suggesting that debt interest, whilst fixed, is also at a relatively low level and has a less significant impact upon the fixed cost base.

Figure 2: 5 year average Gearing Ratios (Source: Fame)
Giving consideration to these costs, I suggest the B&Q SRATC to be U shaped, sitting between flute and saucer shapes and that they are operating close to the optimum volume and thereby lowest cost (see figure 3).

Figure 3: Short Run Cost Curves for B&Q (Source: Own Estimate) I conclude that B&Q are moderately vulnerable to external economic shock, due to the shape of their SRATC curve and to the position on the curve at which they currently operate. 3Market Exposure

B&Q operate within an Oligopoly. The 4-firm market concentration is 86% (see figure 1). In the Kingfisher annual report it is stated “Kingfisher continually monitors and anticipates consumer trends and the activities of its competitors” demonstrating the interdependence characteristic of an oligopoly.

Figure 4: UK DIY Industry Demand Curve
and Top 4 competitors’ Long Run Average Total Cost Curves
Figure 4 shows B&Q’s dominant share of the industry output (sales) and industry leading profitability. I have shown Focus as operating sub-optimally, producing lower outputs (qF) at higher costs (cF) to the point they are now in the loss making position reflected in their financial statements. This may also be due to the company operating at optimum output but at a cost above their LRATC curve. Figure 4 also shows the 4-Firm market concentration as [(qF + qW + qH + qB)/Qi] x 100% In 2006, Kingfisher invested £5.7bn in B&Q UK and measured returns of 7% (Kingfisher 2007) suggesting supernormal profits in excess of the nominal bank rate of 4.5%. This is shown in Figure 4 as the shaded area: π = (Pi - cB) x qB. 3.1Output Market Exposure

Mintel...
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